The novel coronavirus has brought with it a slate of new acronyms such as SARS-CoV-2 and COVID-19. Some have emerged in the financial arena as well that highlight the need for caution in these turbulent times and the role financial advisors can play in shielding investors from their basest instincts.
With interest rates once again at historical lows, many investors who might otherwise have been content to continue holding fixed-income securities have sought to boost their rates of return by turning to stocks instead in a phenomenon dubbed “there is no alternative,” or TINA. According to the TINA worldview, the only viable way for an investor to restore the rates of return that bonds offered formerly is by investing in equities.
Of course, stocks carry different risks than bonds, and investors who shift asset classes simply to replace their formerly high, stable bond cash flows may find themselves facing more volatility than they would like, including the possibility of capital losses. In fact, the magnitude and speed of recent movements in equity markets is among the most extreme ever seen.
Novice investors also have been drawn to the stock market. Some see their peers making a quick buck on a high-risk play and decide to follow suit without professional guidance because “you only live once,” or YOLO.
A current example reveals YOLO’s hidden underbelly. Like many firms in the travel sector, car rental company Hertz Global Holdings Inc. (HTZ-N) has suffered drastic losses from the pandemic and has consequently sought bankruptcy protection. Shareholders are residual claimants and often lose everything when companies become insolvent.
Nevertheless, YOLO-fuelled investor speculation – combined with an excess of idle time during lockdown, receipts of emergency income supplements and the lack of professional sports betting opportunities – drove up Hertz’s stock price to almost ten times its low of US$0.56.
The price surge was especially surprising given Hertz’s management said the shares would likely soon be “worthless.” The share price has since retreated from its recent high, but Hertz’s stock remains a longshot gamble at any price.
A close cousin to YOLO is “fear of missing out,” or FOMO, the modern version of trying to keep up with the Joneses. When social influencers brag about only the best performers among their investments, omitting details that might paint a less rosy picture of their overall financial performance, retail traders can come to expect a level of performance that’s all but impossible to attain.
Further, someone whose portfolio choices are driven by FOMO is almost surely failing to adopt bedrock principles that advisors emphasize, such as diversification and taking a long-term view. In the past, FOMO investors have been drawn into stock markets during periods like the dot-com boom and in the lead-up to the global financial crisis of 2008-09, only to end up with such battered returns that they divested and never came back. We may soon see history repeat itself yet again.
Another new addition to the lexicon of pandemic investing is a twist on an accounting quantity commonly used to evaluate the financial health of a company known as EBITDA, which stands for earnings before interest, taxes, debt and amortization, conveying a company’s net profit after some routine adjustments.
A virus-affected version of this quantity, EBITDAC, with a C for coronavirus, has emerged. This new measure adds back to net profits the hypothetical profits that might have occurred had there never been a pandemic. That adjustment leaves a discomforting degree of room for imaginative thinking.
EBITDAC began as a joke on social media, but a handful of corporate leaders dismayed by their firms’ painfully low earnings numbers adopted the meme as a legitimate metric. Careless investors who accept optimistically massaged numbers as if they were real may find the joke is on them.
The problem with using COVID-19-adjusted financial quantities to inform valuation in the middle of a pandemic is that determining a company’s valuation is necessarily a forward-looking exercise. A firm’s pre-pandemic performance is largely irrelevant to the current intrinsic value of a share and, unfortunately, so are ad hoc coronavirus adjustments.
For this reason, the Ontario Securities Commission and the U.S. Securities and Exchange Commission frown upon companies’ use of financial reporting metrics other than those deemed as “generally accepted accounting principles,” or GAAP, which is an acronym that has been with us since well before the pandemic and will surely endure the tests of time.
With all of the market gyrations, new terminology and strange conditions we’re all living through, one thing remains immutable: advisors can help investors remain on course, unfazed by fads, trends and the pitfalls that can arise from impulsive decisions.
Lisa Kramer is professor of finance at the University of Toronto, where she conducts research and teaches on the topic of behavioural finance. You can follow her on Twitter: @LisaKramer.